The T-1 Capacity Market (CM) auction cleared on Thursday 1 February 2018 in round 14 at £6/kW. 5.78GW of capacity won an agreement for delivery year 2018-19 at an estimated cost for the consumer of £34mn. This is the second one-year ahead auction that has cleared lower than expectations; what does this mean for the upcoming T-4 auction which started today.
We argue the lessons of the T-1 auction are important, but it is not possible to conclude a low clearing price is inevitable. Participants in the current T-4 auction face different risks and uncertainties. Despite the surplus of capacity competing for an agreement in the T-4 auction we believe conditions will drive a higher price than the outturn of the T-1 auction.
The T-1 auction
It was believed the T-1 auction would clear higher, thanks to the large procurement volume required for this delivery year given the failure of the 1.8GW Trafford CCGT and removal of the 2GW Longannet coal fired power station. But, a surplus of capacity pushed the price down to the lowest ever clearing price for a capacity auction. The driver of this surplus over and above what was anticipated is likely to be two-fold; existing capacity that has not retired and distributed new build capacity from previous T-4 auctions that has delivered capacity early and felt confident to participate in the T-1 auction.
On the former, existing capacity remains healthy given revenues for balancing services and short-term wholesale price volatility being higher than originally expected at the time of 2018-19 system modelling, partly due to cash-out reforms. The CM is itself rewarding plant for staying on the system longer. Both indicate that the missing money problem was perhaps not of the magnitude that was originally envisioned at the time of the inception of the scheme.
New build capacity that had won agreements for later delivery years in T-4 auctions, especially smaller cheaper distributed generators, may have commissioned earlier to capture CM prices in the interim auctions and to benefit from triad rates in delivery years before the residual element is radically reduced under CMP 264/265. For example, the 48.5MW Centrica Brigg DG unit won a T-4 contract in 2016 and have now won a T-1 contract for the 2018-19 delivery year.
Despite four coal units participating in the auction only one was successful, highlighting the difficult economic circumstances for some stations. We believe the large shift in the supply curve in round 11 was caused by less economic coal and gas units leaving the auction at the earliest possible point under the price taker rules (no existing generator may exit before £25/kW unless they hold a price maker memorandum approved by Ofgem).
Eggborough, a coal station, has announced its closure following a failure to secure any agreements in the T-1 auction. Eggborough intends to replace the coal fired units with a new 2.5GW CCGT. The Development Consent Order (DCO) was submitted in June 2017 and it is expected the DCO will be granted in March 2018, allowing the new site to participate in the T-4 auction for delivery years 2022-23.
SSE has noted its remaining unit at Fiddlers Ferry (485MW) did not win an agreement but stated the site will remain open to ensure delivery of its other Capacity Market agreements. It is worth noting National Grid is planning on procuring Black Start this year, and this may present an opportunity for Eggborough to remain open beyond the end of its current Capacity Agreements.
However, coal still accounts for over 9.4GW of the capacity procured for this delivery year across the T-1 and T-4 auctions, or 16% of total capacity.
A surprise presence was SSE’s 1.1GW Peterhead CCGT. This site has one of the most expensive TNUoS bills of all generators connected to the transmission system, paying an estimated £14.50/kW in 2018-19. This asset has recently been operating outside of the market providing voltage support in northern Scotland, but it has bought Transmission Entry Capacity back from 2018-19 to its full capacity.
The T-4 auction
Attention will now turn to the T-4 auction that commenced on February 6, 2018. There was a similar magnitude of oversupply before the auction commenced, with 74.6GW of prequalified capacity competing for an agreement – 25GW over the 49.2GW target.
But, delivery year 2021-22, being four years hence, holds significant uncertainties, such as how transmission charging will work, how ancillary services will be procured, the quantum of interconnection and its impacts and the level of wholesale volatility in the power market.
Because of this, many new build generators and some existing generators will likely be seeking higher prices, while coal will be contemplating end of life decisions, driven by the end of the Transitional National Plan, the Industrial Emissions Directive, the recent firming of the BEIS coal closure policy and their own lifecycle maintenance schedules.
Network charging is already a major headache for generators and demand users, for example embedded generators are expected to lose a significant source of income under CMP 264/265 (a decision itself under judicial review, with clarity expected in April).
In addition, there are changes underway as part of the Targeted Charging Review that could see significant shake ups in the way both demand and generation is charged for accessing and using the network, which could even see benefits removed for behind the meter generation.
National Grid’s System Needs and Product Strategy (SNaPS) is reviewing how the System Operator procures its balancing services, aiming to increase transparency and competition, bringing in new participants like storage sites and Demand Side Response. The structure, volumes and prices for these services, which contribute to some thermal stations business models, are uncertain which could also lead to higher exit prices for all providers.
Uncertainty over the development of the interconnector pipeline will also influence parties exit bids, interconnectors should cushion price volatility, absorbing excess power and importing cheap power when prices spike. Interconnector capacity providers are cushioned from wholesale price volatility and capacity clearing prices by their cap and floor agreements (which guarantee revenues), making it more likely they will be delivered. However, these schemes still have major concerns, such as a five-yearly review process, 80% availability requirements, and, of course, Brexit.
The T-4 market for delivery year 2021-22 is sufficiently different from the 2018-19 T-1 that the auction should clear at a higher price and bring forward more new investment, likely in smaller distribution connected gas-fired and some lithium ion storage developments. A higher price to meet the required capacity envelope also means coal fired power stations are likely to remain in the market, as any price good enough for a new build power station is likely to be enough to operate a coal fired asset that does not require significant lifecycle maintenance.
We expect the Electricity Market Reform policies, including the CM, to undergo a review in 2018. Clearing prices as low as last year’s market wide Early Auction and this year’s T-1 auction demonstrates the market can support the capacity required over the short-term to keep stations open with as a little as a years notice, and at very low costs – even if the whole market is auctioned as in the Early Auction. In the T-4 auctions to date, part of the price premium is explicable by uncertainty on wider revenues and loads for all plant four years hence, but also because of the higher costs of new build plant to meet the auction envelope. This combination of outcomes opens up wider questions about whether a market wide T-4 auction for new and existing plant is actually required, or whether a T-1 led auction approach is a more efficient, supplemented by other more targeted and earlier options for new build as and when they are required. This, and other reform ideas, will be food for thought when the EMR review unfolds.